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Uncharted territory: Excitement builds around Cuba hotels, but progress may take years

Cubanlodging companies and their international partners are frantically buildinghotels to meet an expected wave of demand as the U.S. government eases tensionswith the island nation, observers say. Yet with the U.S. trade embargo still inplace, Cuba's hotels likely will take years to catch up to their Caribbeanneighbors.

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Uncharted territory

Recent changes in U.S. relations with Cuba, Myanmar and Iran present a wealth of new opportunities for lodging companies. S&P Global Market Intelligence examines these previously restricted markets in a three-part series.

PresidentBarack Obama moved in December 2014 to loosen restrictions on travel to Cuba,and in June, Starwood Hotels& Resorts Worldwide Inc. made history by taking over of the rebranded FourPoints by Sheraton Havana, the first American-run property in the country sincethe Communist revolution of 1959. The property, built in 2010, is owned byGaviota S.A., a subsidiary of the Cuban military.

Thehotel is part of a three-property deal that Starwood struck with the Cubangovernment, in a breakthrough that likely prefigured other hotel companies'Cuban ventures. MarriottInternational Inc., which is planning to Starwood, has also received U.S.government permission to do business in Cuba, and its CEO, Arne Sorenson,traveled to the island with a U.S. government delegation in March.

Besidescreating the conditions for a wave of U.S. travel to the island, therapprochement appears to have revived interest in Cuba from tourists around theworld, Arturo Garcia Rosa, founder and president of SAHIC, a hotel conferencefocusing on Latin America, said in an interview.

"It'svery funny," said Garcia Rosa, who has made roughly monthly visits to Cubasince 2009. "It's like a lot of Europeans are thinking, 'Well, we wouldlike to go before McDonald's arrives.'"

Room for improvement

Still,while Havana hotels are generally full, and forward-thinking investors havebegun research into the Cuban market, "my observation has been that peopleon all sides of the table are getting ahead of themselves," Mark Lunt,head of Ernst & Young LLP's Caribbean hospitality practice, said in aninterview.

Luntcited legal issues related to Cuban property that has been nationalized overthe years, and lawsuits in both directions related to the embargo and propertyownership, in addition to Cuban infrastructure that he said is not prepared tosupport a dramatic increase in tourism.

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Four Points by Sheraton Havana

Mostimportantly, the U.S. government still permits only certain trips to theisland. Under the current rules, "tourism is still technicallyillegal," Lunt said. "To go to Cuba with the purpose of drinking amojito and hanging out on the beach is not an acceptable category of travel."

Cuba'sexisting hotels will also need work if the island is going to compete with therest of the Caribbean, observers said. The problem is that many properties aregeared toward budget travelers, said Lunt, who visited most recently in 2015with a delegation of U.S. travel industry figures. While hotels meet basicneeds, he added, amenities aimed at luxury or corporate travelers typically arenot present.

"Imaginewhat 50 years of deferred maintenance looks like," he said."Sometimes when you go into the hotel lobbies, it's like going into a timewarp. … There is a tremendous amount of work to be done to bring the resorts toa minimum international standard."

GarciaRosa estimated that at least 90% of existing Cuban hotels need updating,including "very spectacular" luxury properties like the HotelNacional in Havana. While the property could be comparable to the Plaza Hotelin New York, and a standout among its Caribbean peers, he said, it likely willrequire $60 million to $100 million of renovation work.

Land of opportunity?

SeveralCuban hotel owners are hoping to attract international investors to help fundmodernization and new construction, Garcia Rosa said.

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Faro Castillo del Morro, Havana

Inparticular, he said, government-owned entities like Gran Caribe and CubanacanHotels have sought partners to invest debt and equity and have worked withoverseas companies in joint ventures. At present, International hotel groupsled by Spain's Meliá HotelsInternational SA and Canada's Blue Diamond Resorts and Hotelsoperate more than 39,000 hotel rooms on the island, out of roughly 62,000 roomsin total.

Anotherroughly 22,000 rooms are in the pipeline for the next decade, with the vastmajority owned by Gaviota, Starwood's partner on the Four Points Havana, GarciaRosa said. Unlike its competitors, he added, Gaviota typically retains fullownership of its properties, and its discussions with international partnershave focused on management agreements.

Indriving the construction boom, the company aims to use the current moment, alag between relaxed U.S. Cuba relations and a presumed end to the embargo, tolaunch new properties, Garcia Rosa said.

"Whenwe were there, 10,000 rooms were under construction," Lunt said, referringto his September visit. "Not planned, but cranes in the air. Gaviota wasshowing us picture after picture of these hotels that they were building, andwe were saying, 'Is this now?'"

Thewidely held expectation is that most of the new properties will operate underU.S. brands, Garcia Rosa said, adding that multiple U.S.-based brand companiesare interested in the island, along with private equity investors.

Wait and see

Thereis risk in being a first-mover, however. Lunt said many of the new projectsappeared to be aimed at lower-budget, all-inclusive tourism: More like whatCuba currently attracts than what it hopes to attract in the future. Thedanger, he said, is that international brands will come looking to develop inthe future, after relations have loosened further, and find that the bestlocations are already taken by class B properties.

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Cuba
Source: SNL Financial

Difficultiesaside, hospitality observers say Cuba's potential should not be ignored. Theisland has more coastline than the rest of the Caribbean combined, though itmay take a decade or two to develop those beaches, Scott Smith, a managingdirector at CBRE Hotels said. Michael Bellisario, an equity analyst at RobertW. Baird, said REITs would likely not be interested in the island, given theirU.S. focus and the vagaries of Cuban property ownership. But, he added, brandscompanies are likely to pursue Cuban deals.

Lunt,meanwhile, counseled patience. While U.S.-Cuba relations appeared to be movingin a more constructive direction, uncertainty surrounding the upcoming U.S.presidential election appears to have delayed that progress, he said. For now,he added, most investors are seeking contacts on the island and trying to getthe lay of the land.

"Ithink it's very much wait and see," he said, "but get as smart as youcan, and as connected as you can, while we wait."